Derivative Income Funds Level Up

We spend a lot of time bagging on the Global X Covered Call ETF (XYLD) for how little upcapture it has.

The above chart excludes dividends. Without the yield, the compounding is negative. Today I learned there is another variation from Global X, the Global X Covered Call & Growth ETF (XYLG). It is similar to XYLD in that it sells a very near the money, monthly call option. It differs from XYLD is that call are only sold against half the equity portfolio. Where the entire XYLD basket of stocks is pegged at the option's strike price, only half the portfolio of XYLG is pegged so half of the fund can track the index higher which of course it does most of the time. 

XYLG has only been around since late 2020 but it has generally done what you'd expect with returns in between the regular S&P 500 and XYLD. It's not perfectly in the middle but it's close, same with the standard deviation. XYLG's yield was in the 7% range in 2022 and 2023 and seems to be headed there again this year. In 2022, when the S&P 500 was down 18%, XYLG was down 15.5% on a total return basis and down 20% on a price basis. An investor who reinvested the dividends would focus on the 15.5% number and someone who spent the dividend would focus on the 20%. The upcapture on a total return basis was 75% of the S&P 500 with about 85% of the worst downside. 

Yesterday I mentioned that ProShares S&P 500 High Income ETF (ISPY) might have the best combination of upcapture and yield in the derivative income fund space but it occurred to me that XYLG could be in the same ballpark, and it turns out that it is so far but it is still a very short sample period. 

I would not assume that ISPY will always be out in front of XYLG but I do think they will be close to each other most of the time. XYLD and some of the others are going to have higher yields but if ISPY and XYLG can stay close to 7%, that is a shade better than quadruple the market cap weighted index' yield and you can get some upcapture. Oddly, four year old XYLG only has $62 million while eight month old ISPY has $230 million. ISPY is in my ownership universe.

Trying to use XYLG in a portfolio, I built the following to compare.

The thought process is using XYLG as a proxy for backtesting ISPY. Everything is labeled. And here's the portfolio income. Putting 20% into XYLG in Portfolio 1 got the overall yield up to 5% a couple of years but is on pace to come up short of 5% this year.

The rest of Portfolio 1's numbers are pretty good. 

I don't know if this is going anywhere but I believe it supports the ongoing idea that all of these exposures continue to evolve/improve and that it is worthwhile to invest time into staying current as these various strategies evolve. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.